Elasticity, Consumer Surplus, and Producer Surplus Chapter 6 McGraw-Hill/Irwin Copyright © 2009 by...

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Elasticity, Consumer Surplus, and Producer Surplus Chapter 6 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

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Page 1: Elasticity, Consumer Surplus, and Producer Surplus Chapter 6 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Elasticity, Consumer Surplus, and Producer Surplus

Chapter 6

McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Page 2: Elasticity, Consumer Surplus, and Producer Surplus Chapter 6 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter Objectives

• Price elasticity of demand • The total revenue test • Price elasticity of supply• Cross elasticity of demand • Income elasticity of demand• Consumer & producer surplus• Efficiency losses

6-2

Page 3: Elasticity, Consumer Surplus, and Producer Surplus Chapter 6 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Price Elasticity of Demand

• Measuring responsiveness to price changes

• Elastic demand–Large change in quantity

purchased for given price change• Inelastic demand

–Small change in quantity purchased for given price change

6-3

Page 4: Elasticity, Consumer Surplus, and Producer Surplus Chapter 6 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Price Elasticity of Demand

• Price-elasticity coefficient and formula

Percentage Change in QuantityDemanded of Product X

Percentage Change in Priceof Product X

Ed =

6-4

Page 5: Elasticity, Consumer Surplus, and Producer Surplus Chapter 6 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Price Elasticity of Demand

• Calculate percentage change• Restate formula

Change in Quantity Demanded of X

Original Price of X

Ed =

Change in Price of X

Original Quantity Demanded of X

÷

6-5

Page 6: Elasticity, Consumer Surplus, and Producer Surplus Chapter 6 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Price Elasticity of Demand

• Calculation problem• Starting point matters• Midpoint formula

Change in QuantityEd = Sum of Quantities/2

÷Change in Price

Sum of Prices/2

6-6

Page 7: Elasticity, Consumer Surplus, and Producer Surplus Chapter 6 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Interpretations of Elasticity

Elastic Demand

Inelastic Demand

Unit Elasticity

Ed = .04.02 = 2

Ed = .01.02 = .5

Ed = .02.02 = 1

6-7

Page 8: Elasticity, Consumer Surplus, and Producer Surplus Chapter 6 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Price Elasticity of Demand

• Why use percentages?–Unit free measure–Compare responsiveness across

products

• Elimination of the (-) sign• Extreme cases

–Perfectly inelastic demand–Perfectly elastic demand

6-8

Page 9: Elasticity, Consumer Surplus, and Producer Surplus Chapter 6 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

The Total Revenue Test

• Total Revenue = TR = PxQ

• Inelastic demand–P and TR change in same direction

• Elastic demand–P and TR change in opposite

direction

6-9

Page 10: Elasticity, Consumer Surplus, and Producer Surplus Chapter 6 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

$3

2

1

0 10 20 30 40 Q

P

• Lower price and elastic demand–Blue gain exceeds gold loss

a

b

D1

The Total Revenue Test

6-10

Page 11: Elasticity, Consumer Surplus, and Producer Surplus Chapter 6 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

$4

3

2

1

0 10 20 Q

P

• Lower price and inelastic demand–Gold loss exceeds blue gain

c

d

D2

The Total Revenue Test

6-11

Page 12: Elasticity, Consumer Surplus, and Producer Surplus Chapter 6 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

$3

2

1

0 10 20 30 Q

P

• Lower price and unit-elastic demand–Blue gain equals yellow loss

e

fD3

The Total Revenue Test

6-12

Page 13: Elasticity, Consumer Surplus, and Producer Surplus Chapter 6 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

]]]]]]]

Elasticity on a Linear Demand Curve

1

2

3

4

5

6

7

8

$8

7

6

5

4

3

2

1

5.00

2.60

1.57

1.00

0.64

0.38

0.20

$8,000

14,000

18,000

20,000

20,000

18,000

14,000

8,000

Elastic

Elastic

Elastic

Unit Elastic

Inelastic

Inelastic

Inelastic

(1)Total Quantity of

Tickets DemandedPer Week, Thousands

(2)Price Per Ticket

(3)Elasticity

Coefficient (Ed)

(4)Total Revenue

(1) X (2)

(5)Total-Revenue

Test

]]]]]]]

6-13

Page 14: Elasticity, Consumer Surplus, and Producer Surplus Chapter 6 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Elasticity and the TR Curve

0 1 2 3 4 5 6 7 8

0 1 2 3 4 5 6 7 8

Quantity Demanded

Quantity Demanded

Pri

ceT

ota

l Rev

enu

e(T

ho

usa

nd

s o

f D

olla

rs)

$201816141210

8642

$87654321

a

bc

de

fg

h

ElasticEd > 1

Unit ElasticEd = 1

InelasticEd < 1

D

TR

6-14

Page 15: Elasticity, Consumer Surplus, and Producer Surplus Chapter 6 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Determinants of Elasticity

• Substitutability–More substitutes, more elastic

demand• Proportion of income

–Price relative to income• Luxuries versus necessities

–Luxuries are more elastic• Time

–More elastic in the long run 6-15

Page 16: Elasticity, Consumer Surplus, and Producer Surplus Chapter 6 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Applications of Elasticity

• Large crop yields–Inelastic demand

• Excise taxes–Inelastic demand

• Decriminalization of illegal drugs–Elastic or inelastic demand?

6-16

Page 17: Elasticity, Consumer Surplus, and Producer Surplus Chapter 6 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Price Elasticity of Supply

Percentage Change in QuantitySupplied of Product X

Percentage Change in Priceof Product X

Es =

Responsiveness to price changes by producers

6-17

Page 18: Elasticity, Consumer Surplus, and Producer Surplus Chapter 6 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Price Elasticity of Supply

• Market period–Perfectly inelastic supply

• Short run–Fixed plant size

• Long run–Adjustable plant size

–Supply more elastic6-18

Page 19: Elasticity, Consumer Surplus, and Producer Surplus Chapter 6 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

P

Q

Price Elasticity of Supply

The Market Period• Perfectly inelastic supply

D1 D2

Sm

Q0

Pm

P0

GreatestPrice

Impact

6-19

Page 20: Elasticity, Consumer Surplus, and Producer Surplus Chapter 6 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Price Elasticity of Supply

The Short Run• Inelastic supply

P

Q

D1 D2

Ss

Q0

Ps

P0

Qs

LowerPrice

Impact

6-20

Page 21: Elasticity, Consumer Surplus, and Producer Surplus Chapter 6 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Price Elasticity of Supply

The Long Run• Elastic supply

P

Q

D1 D2

Sl

Q0

Pl

P0

Ql

LeastPrice

Impact

6-21

Page 22: Elasticity, Consumer Surplus, and Producer Surplus Chapter 6 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Price Elasticity of Supply

• Applications• Antiques and reproductions

–Limited, inelastic supply–Strong demand–Resulting high price

• Volatile gold prices–Inelastic supply–Shifting demand

6-22

Page 23: Elasticity, Consumer Surplus, and Producer Surplus Chapter 6 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Cross Elasticity of Demand

• Responsiveness of sales to change in price of another good

Percentage Change in QuantityDemanded of Product X

Percentage Change in Priceof Product Y

Exy =

6-23

Page 24: Elasticity, Consumer Surplus, and Producer Surplus Chapter 6 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Cross Elasticity of Demand

• Substitute goods–Positive sign

• Complementary goods–Negative sign

• Independent goods–Zero

6-24

Page 25: Elasticity, Consumer Surplus, and Producer Surplus Chapter 6 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Income Elasticity of Demand

• Responsiveness of sales to

change in income

• Normal goods – positive sign

• Inferior goods– negative sign

Percentage Change in QuantityDemanded

Percentage Change in IncomeEi =

6-25

Page 26: Elasticity, Consumer Surplus, and Producer Surplus Chapter 6 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Consumer Surplus

• Benefit surplus• Maximum willingness to pay (WTP)

less than actual price paid

Person Max WTP Actual Price CSBob $13 $8 $5Barb $12 $8 $4Bill $11 $8 $3Bart $10 $8 $2Brent $9 $8 $1Betty $8 $8 $0

6-26

Page 27: Elasticity, Consumer Surplus, and Producer Surplus Chapter 6 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Consumer Surplus

D

Pri

ce

(P

er B

ag

)

P1

Q1

Quantity (Bags)

ConsumerSurplus

Equilibrium Price = $8

6-27

Page 28: Elasticity, Consumer Surplus, and Producer Surplus Chapter 6 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Producer Surplus

• Benefit surplus• Actual price received more than

minimum acceptable price (AP)

Person Min AP Actual Price PSCarlos $3 $8 $5Courtney $4 $8 $4Chuck $5 $8 $3Cindy $6 $8 $2Craig $7 $8 $1Chad $8 $8 $0

6-28

Page 29: Elasticity, Consumer Surplus, and Producer Surplus Chapter 6 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Producer Surplus

SP

ric

e (

Per

Ba

g)

P1

Q1

Quantity (Bags)

ProducerSurplus Equilibrium

Price = $8

6-29

Page 30: Elasticity, Consumer Surplus, and Producer Surplus Chapter 6 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Efficiency Revisited

• Productive and allocative efficiency

D

SP

ric

e (

Per

Ba

g)

P1

Q1

Quantity (Bags)

ConsumerSurplus

ProducerSurplus

Equilibrium Price = $8

6-30

Page 31: Elasticity, Consumer Surplus, and Producer Surplus Chapter 6 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Efficiency Loss

• Deadweight loss

D

SP

ric

e (

Per

Ba

g)

P1

Q1

Quantity (Bags)

EfficiencyLosses

Q2 Q3

6-31

Page 32: Elasticity, Consumer Surplus, and Producer Surplus Chapter 6 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Elasticity and Pricing Power

• Competitive markets–No pricing power

• Firms with market power–Charge different prices

• Differences in group elasticities–Business vs. leisure travelers–Discounting for children–College tuition

6-32

Page 33: Elasticity, Consumer Surplus, and Producer Surplus Chapter 6 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Key Terms

• price elasticity of demand

• midpoint formula• elastic demand• inelastic demand• unit elasticity• perfectly inelastic

demand• perfectly elastic

demand• total revenue (TR)• total-revenue test

• price elasticity of supply

• market period• short run• long run• cross elasticity of

demand• income elasticity of

demand• consumer surplus• producer surplus• efficiency losses

(deadweight losses)6-33

Page 34: Elasticity, Consumer Surplus, and Producer Surplus Chapter 6 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

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Consumer Behavior

6-34


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